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Report Rebuts Goldman's Claim on AIG

Source: WSJ

Posted on 18 Nov 2009

For more than a year, Goldman Sachs Group Inc. has maintained that it wouldn't have suffered material losses had the government allowed one of its major trading partners, American International Group Inc. (AIG), to collapse. A government report throws cold water on that claim.

Goldman was among the largest beneficiaries of a decision by the Federal Reserve Bank of New York to bail out insurer AIG in September 2008 at the height of the financial crisis. The Fed agreed to pay Goldman and 15 other banks, in full, for $62 billion of insurance contracts they had with AIG to protect against price drops of mortgage securities they held.

The report, issued this week by the special inspector general for the Troubled Asset Relief Program, comes amid controversy over whether the government unfairly helped out big banks in its bailout of AIG. The government auditor's report broadly found that the New York Fed left itself little room in negotiating with the banks for a better deal for taxpayers.

Goldman's trading position with AIG centered on $22.1 billion of such insurance the firm had purchased from AIG. In a separate series of trades, Goldman itself had sold protection against losses on the same securities to other trading firms.

The problem for Goldman: If AIG collapsed and markets continued to swoon, Goldman would have had to make payments to the other trading firms and been unable to collect on protection it had bought from AIG.

Underlying many of these credit bets was a mass of mortgage debt, securities backed by pools of subprime home loans and commercial real-estate debt, and then more complicated securities also linked to mortgages. The packaging of all those securities helped fuel the U.S. housing boom and subsequently sparked the credit crisis.

Goldman has said it was insulated against a material loss by an AIG default. And the audit pointed out that Goldman in fact was protected against some losses. For example, the firm had collected $8.4 billion of collateral, cash or a liquid equivalent, from AIG. Separately, Goldman took steps to try to buy insurance against insurance by purchasing protection against an AIG default.

But the audit raised questions about Goldman's calculations. Goldman believed that it controlled $4.3 billion in assets, pools of fixed-income securities that require complex computer modeling to design and understand, that would have been used to counter an AIG default. The securities are called collateralized debt obligations, or CDOs.

The audit said, however, that given the fact that the market for those securities had tanked in November 2008, and that an AIG default would have sparked a rout, Goldman would have had a difficult time obtaining value for those assets.

"It is far from certain that the underlying CDOs could have easily been liquidated, even at the discounted price of $4.3 billion, the audit found.

The audit also said Goldman would have faced the same problem of declining market value for another pool of assets valued at $5.5 billion had AIG defaulted. The bottom line: The audit said those assets that Goldman held would have been worth a lot less had AIG failed.

In a statement, a Goldman spokesman reiterated that the firm was protected against losses tied to an AIG failure: "Goldman Sachs has consistently said its exposure with AIG was collateralized and hedged and therefore we had no direct credit exposure. Given the hedges, collateral and government backing as a result of the bailout, the additional risks of declining market values in the event of an AIG default are a moot point."

A spokeswoman for the special inspector overseeing the Troubled Asset Relief Program wasn't available for comment. The New York Fed said it "acted appropriately" in its dealings with AIG trading partners.

The audit also raised questions about the insulation Goldman had purchased against an AIG default. Goldman bought that protection from other financial firms. The audit said that had AIG defaulted, Goldman might have faced a difficult time actually collecting on that protection, which totaled at least $1.2 billion.

In a trade that is emblematic of the complex hedges financial firms take—making a bet, then buying protection against that bet and then seeking collateral to cover the protection—Goldman officials told government auditors that it had collateral to protect against a loss on the AIG default insurance.